What is a gift?

You want to help your child with the purchase of their new home but you are worried you will have to pay a ‘gift tax.’ What exactly is this tax and how does it work. Well, to start, the IRS defines a gift as “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.” In other words, if you give someone something of value and don’t receive an equal value in return, you’ve given them a gift.

How are gifts taxed?

Gifts that you or your child receives are not considered income, and don’t get reported on your tax return. That being said, you can’t simply dodge taxes by calling your income a gift. If, for example, you receive a “gift” in return for services rendered, it’s not a gift.

So what’s all this talk about gift taxes? The gift tax actually applies to the donor, not the recipient. The whole point of this tax is to prevent individuals from transfer their estate to others before their death, thereby avoiding the estate tax.

Exclusions from the gift tax

There is an annual gift tax exclusion that currently stands at $13k/recipient. In other words, you’re allowed to give away up to $13k  per recipient per year, to as many recipients as you wish, without any tax implications. This limit is effectively doubled for married couples, who can jointly give gifts up to $26k/year total to a single recipient.

As importantly, there is also a second, $1M lifetime limit of gifts in excess of the $13k annual limit before the gift tax is triggered. If you exceed this limit, then you’ll either have to pay the gift taxes that year, or use up a portion of this lifetime limit that would otherwise be used to offset the estate tax upon your death.

Gift tax returns and the gift tax rate

If you exceed the annual exclusion of $13k/recipient, you’ll have to file a gift tax return. But remember, you still won’t have to pay the gift tax until you reach the $1M lifetime limit. What happens once you exceed your $1M lifetime limit? How much will you owe?  At that point, the gift tax rate is, essentially, the estate tax rate and the amount owed will depend upon the estate tax rates in force at that time.

It used to be fairly safe to tell buyers that the maximum contribution that a seller could make toward the buyer’s closing costs was 3%. Unfortunately, this is no longer the case. Here’s where we currently stand:

• FHA is 6% regardless of down payment.
• Conventional is 3% if the down payment is less than 10%, 6% if the down payment is 10% or more but less than 25% and finally, 9% if the down payment is 25% or more
• For jumbo loans, if the down payment is less than 20%, the maximum contribution is 3% and if the down payment is 20% or more, the max is 6%.
• For VA loans, the seller can pay all non-recurring costs and up to 4% for anything else.
• If you are purchasing investment property, the maximum amount that can be paid is simply 2%.

Many folks are not aware of the last bullet and, often, contracts are written up with excess contributions that need to be corrected prior to loan submission. Keep in mind that these contributions can only be for acceptable closing costs and pre-paid expenses. More on that later.

Are you thinking about becoming a landlord?   The number one question for prospective landlords is how to finance such a purchase. Typically, non-owner occupied one through four unit properties are considered ‘conventional’ loans by most Lenders, while five plus units are considered ‘commercial’.  Conventional one to four unit properties are often much easier to finance. However, due to the recent financial and credit ‘crunch’, one and two unit investment properties now require a minimum 20% down payment by most lenders.  Three- four unit properties typically require a 25% down payment. The Lender will determine the risk involved in acquiring rental property by looking at the buyer’s personal finances and the projected rental income.  However, if you don’t have landlord experience, many lenders will require you to qualify without using rental income. Finally, lenders will want to make sure that the borrower has sufficient reserves to handle contingencies, such as repairs, maintenance, and taxes and insurance.

If you are saving for a new home, you may feel that it will take you
forever to come up with the cash necessary for the down payment and closing costs. Before you delay your purchase any longer, make sure you check into the latest low down and no down mortgage products. You may find that your dream is much closer to a reality than you imagined. If you have acceptable credit and a steady job, you may not need a lot of cash to purchase a home. Some loan programs still allow you to put as little as 0 down if you are a veteran or are buying in an area designated as ‘rural’ by the USDA. For example, in Vermont, the Vermont Housing Finance Agency (VHFA) still offers a 100% financing program when combined with Rural Development’s mortgage insurance. If you are a veteran you can also obtain 100% financing through the VA’s loan program. If you don’t meet the above criteria you can purchase with as little as 3.5% down using Federal Housing Administration (FHA) financing and all of this money can even be a gift from family. By doing a pre-purchase credit check you can verify if you qualify for any of these programs or if you need to work on resolving any credit problems before you begin your search for a home. Buyers who thought they were years away from the purchase of a home are often pleasantly surprised to find that they don’t have to wait to begin their search.

When a marriage ends in divorce, the lives of those involved are changed forever. During this time of upheaval, one thing that shouldn’t have to change is the credit status you’ve worked so hard to achieve. Unfortunately, for many, the experience is the exact opposite. Unfulfilled promises to pay bills and a breakdown in communication can lead to unwanted credit issues. These issues may affect your ability to refinance your current loan or purchase a new home. The good news is it doesn’t have to be this way. By taking a proactive approach and creating a specific plan to maintain your credit status, you can ensure that “starting over” doesn’t have to also mean rebuilding credit. The first step is to obtain a valid copy of your credit report. Once you’ve gathered the facts, it’s time to make a plan: Can you purchase a new home now or will you have to wait until everything is finalized? Can you refinance the house to pay off your spouse and consolidate debt? These are some of the questions that a trained mortgage professional can assist you with. Divorce is difficult for everyone involved. By having professional advice, both legal and financial, you can ensure that your credit remains intact.

Title insurance companies ensure that sellers have clear title to the property they are selling. The title insurance company’s agent performs a thorough search of the public records and certifies that the proper parties signed the paper work, paid the taxes and discharged all liens each time the house changed hands. Why then, does a buyer need title insurance if these searches are so meticulous? Public records can be incorrect if a mistake was made when the legal document was recorded. When you buy owner’s title insurance, you are protected against forgeries, misrepresentation and mistakes made at any point during the chain of ownership. Someone may have forged a deed, divorce papers or a death certificate. For a one-time premium, title insurance provides protection against title claims even long after you sell your home. Legal expenses and other costs are paid by the company to defend your title. In Vermont, many title issues arise due to permit problems. One type of owner policy insures against loss arising from failure to have certain kinds of permits. Storm water issues are also making headlines and title problems could arise due to the complicated permitting requirements. Title insurance is like emergency oxygen on an airliner. You may never need it, but if you do, you will be really glad that you have it!

Many borrowers wonder, “when is the right time to refinance”? A simple answer to this question is to take the total cost of the refinance and divide it by the monthly savings. For example if the total cost to refinance is $2000 and the monthly savings is $100 the break even is 20 months or nearly two years. In this case, if you are planning on staying in the property (or the loan) for more than two years you should refinance.  But what if rates drop within that two-year break-even period? In many cases it is beneficial to look at a relative newcomer to the refinance arena - the no cost refinance.  If the cost to refinance is zero, as it is with a true no cost refinance program, than go ahead and refinance no matter how long you plan to stay in the property. Furthermore, if rates drop after you close, you can simply refinance again with no closing costs. The only downside of the no cost refinance is that you will pay a slightly higher rate than if you pay closing costs to refinance.  Mortgage rates have risen in recent months and if your rate is 5.75% or higher (or you have an adjustable rate mortgage) now may be a good time to check into the best refinance options for you.

Many people hate their mortgage because they know over the life of the 30 year loan, they will spend more in interest than the house cost in the first place. To save money it becomes very tempting to make a bigger down payment or make extra principal payments. Unfortunately, saving money is not the same as making money. Or, to put it another way, paying off debt is not the same as accumulating assets. By tackling the mortgage pay-off first, and savings goal second, many fail to consider the important role that a mortgage can play in asset accumulation.  

Consider this: Every dollar we give the bank is a dollar we did not invest. While paying off the mortgage saves us interest, it denies us the opportunity to earn interest with that money. It is quite possible to earn more from a conservative investment than a tax favored mortgage loan is costing us. Contact your financial advisor to determine if this strategy would work for you.